In previous recessions, while most professionals were bemoaning the lack of activity, there was always one adviser who would secretly be rubbing his or her hands with glee. No matter how concerned they might be about companies getting into difficulties, the turnaround partners in any large organisation would know that a downturn meant an upturn for them.
Except, that is, in this recession. For anyone will tell you that one characteristic of the last few months has been the relative lack of people getting into trouble. There have been notable collapses, but nothing like the carnage that has characterised earlier downturns.
What’s the reason for this? One seasoned industry observer, John Swarbrick, head of private equity house LDC in Leeds, believes it may be the unusual circumstances of this recession; in particular the historically low interest rates.
Companies may be in trouble, but the amount of money they have to pay in servicing those problems is relatively small, so they can probably struggle on through. Other demands on their capital may also be diminished.
Andrew Foster, area director for business support at the Lloyds Banking Group, says HMRC’s Time to Pay initiative may considerably have helped small businesses who otherwise might be facing extinction. This service, launched last year, gives them extra time to pay the tax they owe.
By February this year, 60,000 businesses had made agreements with HMRC that amounted to £1bn in deferred tax. “You also have to remember that businesses tend to throw off cash as they go down, rather than take it on,” says Foster. “And bank facilities may not be as constrained as they were at the start of the credit crunch.” Many advisers also comment that banks are now more willing to hold on to companies which in previous hard times they might have let go to the wall, or at the very least palmed off on a specialist fund which would pick over the remains.
Foster points to an increasing tendency for banks to go for debt for equity swaps – which effectively means the bank taking a significant if not controlling stake in the business. In the past few months, Yorkshire has seen this with Heywood Williams and White Young Green.
Certainly, you would think a downturn would be good news for the one organisation in Leeds that in the past decade has really made a name for itself in turnaround – Endless, the turnaround fund currently celebrating its fourth birthday.
In that short time the fund has scored some big successes, their biggest so far including turning around the logistics company Peter Black and the engineering firm Davy Markham. The latter, “went through 27 years of consecutive losses and is now making a profit”, says co-founder Darren Forshaw.
Retail businesses have also proved a strong focus, such as The Works discount book store, which Endless acquired in May 2008, five months after it had gone into administration. “It had just lost more than £6m the year before,” he says.
“But in its first year it made £3m EBITDA under our ownership, and this year it is making £9m.” In the early years, many of these deals were property plays. Although Davy Markham was successfully turned around on its own, the business has been consolidated onto a much smaller site than when Endless took over.
The freed-up land has been turned into a business park by property developer David Newitt - one of Endless’s earliest investors.
Yet Forshaw says property now features in only half the deals the fund does, and had no part to play in the biggest deal it has ever done; the acquisition in 2009 of stationery products supplier Vasanta.
Endless prides itself on its speed in turning around deals, and the fortnight it took to do this one was no exception.
“It was a buyout that had gone wrong many years ago,” says Forshaw. “Two businesses had been acquired and put together led by a private equity house with a lot of bank debt. At the turn of the year, the credit insurers took a very dim view of the sector and withdrew cover.” The deal, which was backed by a syndicate of seven banks, certainly helped to raise Endless’s profile, particularly in the south.
But it was more or less the only deal Endless has done in the past year. The fund is still managing its existing portfolio.
“In our last report to our investors we reported an increased valuation of 70 per cent,” says Forshaw, “in a market where people are reporting reduced values.” They have been approached about possible sales too, and Forshaw says they might make one or two exits in the next 18 months. But other investment opportunities have not materialised.
Forshaw says it is, “clearly much easier to fix a business in a more benign economy than in a downturn”. But he agrees with the others that there has also been fundamental change of approach from the banks. “The banks have been internalising their issues,” he says.
“They are having to deal with the first few phases.” This might be an odd scenario for anyone who witnessed the phenomenon of cash-strapped banks at the start of the credit crunch, but Endless managing director Chris Clegg says things have moved on since then.
“For the first six months after the Lehman Brothers collapse, the banks were underresourced and were incapable of doing anything,” he says. “But we are in the second phase now.
The rise in the banks’ internal bad debt book seems about five-fold.” Which makes you wonder whether there isn’t some political pressure here, particularly on the banks who had to go to the Government to get support. Is it saying to them that, as they have been bailed out, they should go easy on other struggling companies? “Whether it is politically motivated I couldn’t say,” says Jonathan Jones, Leeds office managing partner at Hammonds solicitors.
“But as HMRC is being generous too, you do have to wonder.” The big question exercising everybody’s minds at the turn of the year, then, is how much longer this state of affairs can continue. Forshaw thinks such internalised businesses will go through several stages of funding and refunding first, before the banks decide enough is enough.
“There won’t be a fire sale,” he says, “but businesses will lead out over a period.” Martin Jenkins, corporate finance partner at Deloitte, agrees, saying the crunch will come when the banks or funders realise that whatever restructuring they have done hasn’tworked.
“You have to ask yourself whether the restructuring has delivered what it was supposed to,” he says. There is also the question of whether banks like being long-term owners of businesses in this way. Forshaw and Jenkins both say they don’t.
“The banks just aren’t set up to manage businesses that are underperforming,” says Forshaw. “We have 20 people at Endless who are here to do that day in, day out. We can afford to put people into business full time.
The banks aren’t set up to do that.”
However John Swarbrick at LDC in Leeds is less sure. Banks may have been unwilling owners in the past, he says, but they are getting around to it now.
“Running a business requires a different mindset,” he says, “but it is one the banks are determined to show they can adopt.” One factor that could have a big influence is the result of the 2010 general election. After all, that £1bn in potential tax payments the HMRC has set aside amounts to £1bn lost to the exchequer.
An incoming government, of whatever colour, might choose to show it is serious about reducing public debt by reverting to the normal tough line on tax, and that might send more businesses into the arms of turnaround people.
“I would say it would be good if some businesses were allowed to fail,” says Jones. “That would allow new opportunities to set in.” New opportunities for new funds, too. For while in recent years Endless has had the turnaround market in the north pretty much to itself, two new funds – Eternitas and NorthEdge capital – have now sprung up offering something similar. The latter is run by, among others, two former LDC directors. Battle lines look set to be drawn next year.
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